GST ready to roll: But history shows it could stoke inflation

NEW DELHI: With the GST Council fixing the tax rates for goods and services, India is now all set to usher in the game-changing tax reforms from July 1.

While industry and market analysts are bullish on this massive tax overhaul that will transform the country into one single market, the average man on the Street is confused whether the new tax structure would stoke inflation in the initial period of its implementation.

History shows economies that implemented tax systems similar to GST in the past experienced a spike in inflation, though the same was not uniform.

Among the countries that witnessed a surge in inflation included Singapore and Australia.

In Australia, GST had a significant but transitory impact on inflation with a lag of one quarter after its implementation in July 2000, an RBI study released earlier this month showed.

It took 25 years for Australia to implement the GST in 2000 after first mooting the idea in 1975. Australia imposed a 10 per cent tax on goods and services and replaced a range of existing taxes, including a wholesale sales tax (WST), debit tax, financial institutions duty, and stamp duty on shares, leases, mortgages and cheques.

New Zealand also witnessed a one-off increase in inflation after GST implementation, which normalised within a year. Canada, where the GST replaced the manufacturer’s sales tax also temporarily impacted prices.

Malaysia was among the countries that managed to mitigate this risk, as Ministry of Domestic Trade and Consumer Affairs intervened actively to tame the price rise, the RBI report cited.

Will India see a rise in inflation following GST implementation?

“The impact of GST in most countries has been little inflationary. When you get into a GST regime, the tax rates go up for some commodities and come down for others,” said DK Joshi, Director & Chief Economist, CRISIL.

“The impact on inflation is not merely a function of how the tax rates have moved, but a function of producer behaviour. The way the GST has been crafted does not look inflationary, but the government has to ensure that the tax reductions get passed on to the end consumer,” Joshi said.

Singapore taxes virtually everything at a single rate, while many others such as France, Italy and the UK have multiple tax slabs.

The RBI note suggested that GST implementation “is likely to have a pass-through impact on inflation trajectory, lasting 12 to 18 months.”

“This would eventually moderate by a reduction in supply chain rigidities and easing of transportation and production costs which would accrue from the creation of a unified goods and services market post GST,” the note said.

JM Financial said the government had done well to preserve the neutrality of tax incidence across products, as it believes the twin objective of maintaining revenue neutrality and controlling inflation could be achieved.

“Early announcement of rates also implies that sufficient time is available to the industry to adjust their pricing strategies while transitioning to the new regime,” it said.